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2017 Article IV Consultation with the United States of America - Concluding Statement of the IMF Mission

June 27, 2017

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

The Macroeconomic Outlook

1.
The U.S. economy is in its third longest expansion since 1850. Real GDP is now 12 percent higher than its pre-recession peak, job
growth has been persistently strong and, although there are measurement
uncertainties, the U.S. economy appears to be back at full employment.

2.
However, the outlook is clouded by important medium-term imbalances.The U.S. economic model is not working as well as it
could in generating broadly shared income growth. It is burdened by a
rising public debt. The U.S. dollar is moderately overvalued (by around
10-20 percent). The external position is moderately weaker than implied
by medium term fundamentals and desirable policies. The current account
deficit is expected to be around 3 percent of GDP over the medium-term
and the net international investment position has deteriorated markedly
in the past several years. Most critically, relative to historical
performance, post-crisis growth has been too low and too unequal.

3.
To address these shortcomings, the administration intends a
wide-ranging overhaul of policies, although a fully articulated
policy plan has yet to emerge. The administration’s budget proposes to reduce the fiscal deficit and
debt, to reprioritize public spending, and to revamp the tax system.
However, during the Article IV consultation it became evident that many
details about these plans are still undecided. Given these policy
uncertainties, the IMF’s macroeconomic forecast uses a baseline
assumption of unchanged policies. Specifically, it neither builds in
the effect of tax reform nor the expenditure reductions proposed in the
administration’s budget. Under this forecast, growth is expected to
rise modestly above 2 percent this year and next, driven by continued
solid consumption growth and a cyclical rebound in private investment.
Growth is forecast to subsequently converge to the underlying potential
growth rate of 1.8 percent.

4.
Significant policy uncertainties imply larger-than-usual, two-sided
risks to the forecast. On the one hand, a medium-term path of fiscal consolidation, such as
that proposed in the budget, would result in a growth rate that is
below this baseline. On the other hand, spending reductions could be
less ambitious and tax reforms could lower federal revenues, providing
stimulus to the economy, raising near-term growth (and possibly
potential growth), but with negative implications for debt
sustainability and the current account imbalance. Over the medium-term,
a broader retreat from cross-border integration would represent a
downside risk to trade, sentiment, and growth.

Policy Goals

5.
Like many other advanced economies, the U.S. is being confronted
with secular shifts on multiple fronts. These include technological change that is reshaping the labor
market, low productivity growth, rising skills premia, and an aging
population. Despite having high per capita income and being one of the
most flexible, competitive, and innovative economies in the world, the
U.S. model appears to be having difficulties adapting to these secular
changes. As was pointed out in the administration’s budget, these
shifts are having real consequences for people’s livelihoods: household
incomes are stagnating for a large share of the population (in
inflation-adjusted terms, more than half of U.S. households has a lower
income today than they did in 2000); job opportunities are
deteriorating with many workers too discouraged to remain in the labor
force (since 2007, the labor force participation rate has fallen from
66 to below 63 percent of the non-institutionalized civilian
population); prospects for upward mobility are waning; and the poverty
rate (at 13.5 percent) is one of the highest among advanced economies.

6. A comprehensive policy package is needed.
The administration’s priorities include taking steps to spark faster
economic and productivity growth, stimulate job creation, incentivize
business investment, balance the budget, bring down the public debt,
and create fiscal space to finance priorities such as infrastructure.
These objectives are welcome but the consultation revealed differences
on a range of policies and left open questions as to whether the
administration’s proposed policy strategies are best suited to achieve
their intended purpose. Nonetheless, there was agreement that the
policy package will need to incorporate reforms on multiple,
macro-critical fronts. These include building a more efficient tax
system, improving education and developing skills, reprioritizing
federal spending, improving the effectiveness of the regulatory system,
and reforming the immigration and welfare systems. The right policy
package represents an upside risk to growth and would serve to ensure a
broad-based improvement in living standards. The remainder of this
concluding statement aims to outline a possible set of macroeconomic
and supply-side policies that would achieve such an outcome.

7.
However, it should be said at the start that, even with an ideal
constellation of pro-growth policies, the potential growth dividend
is likely to be less than that
projected in the budget and will take longer to materialize. The U.S. is effectively at full employment. For policy changes to be
successful in achieving sustained, higher growth they would need to
raise the U.S. potential growth path. The international experience and
U.S. history would suggest that a sustained acceleration in annual
growth of more than 1 percentage points, as projected by the
administration, is unlikely. Indeed, since the 1980s there are only a
few identified cases among the advanced economies where this has
happened. These episodes mostly took place in the mid to late 1990s
against a backdrop of strong global demand and many of them were
associated with recoveries from recessions. The U.S. itself experienced
one comparable growth acceleration as it recovered from the deep
recession of the early 1980s. However, this event occurred during a
period of favorable demographics, rising labor force participation, a
significant expansion of the federal fiscal deficit, and an
acceleration in trading partner growth. These tailwinds are unlikely to
recur today.

The Macroeconomic Policy Mix

8.
With the economy at full employment it is important that the U.S.
puts in place the right policy mix for this stage in the cycle. That would involve gradually removing both fiscal and monetary
support and refocusing efforts on expanding potential growth, raising
competitiveness, and strengthening the supply side. Doing so will lower
the current account deficit and improve the net international
investment position, reduce the overvaluation of the U.S. dollar, and
have positive spillovers to others. There are two parts to this policy
shift:

Part 1: A balanced medium-term fiscal consolidation

9.
Under unchanged policies, demographic trends and rising interest
rates will lead to a steady increase in fiscal deficits and public
debt over the medium-term. To prevent this, the U.S. should put in place a plan for medium-term
fiscal consolidation that targets a federal primary surplus of around 1
percent of GDP (or a general government primary surplus of around ¾
percent of GDP). This adjustment can be gradual but ought to start in
2018 so as to lower the federal debt-GDP ratio over the medium-term.

10.
The administration’s budget proposes an expenditure-based
medium-term fiscal consolidation. Under the authorities’ budget, the federal primary balance is
forecast to go from a 1.9 percent of GDP deficit to a 2.1 percent of
GDP surplus over the next 10 years. This adjustment is predicated on a
modest increase in revenues, a reduction in both non-defense spending
and defense outlays as a share of GDP, and an extremely optimistic
growth assumption. The non-defense spending reductions are concentrated
in two broad areas: a downsizing of line agencies (outside of defense
and security) and reductions in spending on safety net programs. Fewer
details are currently available on the tax reform that the budget is
based upon but our understanding is that it will be designed to improve
efficiency and lower marginal rates while leaving the federal
revenue-GDP ratio broadly unchanged.

11.
A different composition of adjustment could stabilize the public
debt-GDP ratio with smaller costs to growth and living standards. As currently framed, the budget implies significant cuts to
discretionary spending that, in the staff’s view, would seem to place a
disproportionate share of the adjustment burden on low- and
middle-income households. This would appear counter to the budget’s
goals of promoting safety and prosperity for all Americans. An
alternative approach would rely on:

More balanced expenditure restraint that strengthens the
effectiveness and efficiency of the safety net and reprioritizes
appropriations, increasing spending on those programs that encourage
labor force participation, improve infrastructure, and raise
productivity and human capital.

Measures to reform the social security system including raising the
income ceiling for social security contributions, indexing benefits to
chained CPI or PCE inflation, raising the retirement age, and
instituting greater progressivity in the benefit structure.

12.
With the Federal Reserve having largely achieved its dual mandate
of price stability and maximum employment, policy rates should
continue to rise. The pace of rate increases can be gradual, especially when compared
with previous tightening cycles, and should certainly be data
dependent. Given the downside risks to inflation and the asymmetries
posed by the effective lower bound, the Federal Reserve should be ready
to accept some modest, temporary overshooting of its inflation goal
that allows inflation to approach the 2 percent medium-term target from
above. Doing so would provide valuable insurance against the risks of
disinflation and having to bring the federal funds rate back down to
zero.

13.
Alongside the ongoing normalization in policy rates, it is
appropriate that the Federal Reserve looks to unwind the
post-crisis increase in its holdings of treasury and mortgage
backed securities. Given the risk of triggering an unexpected steepening of the yield
curve or a rise in MBS spreads, plans for the Fed’s balance sheet
should be well-telegraphed at an early stage. The recent addendum to
the policy normalization principles and plans provides market
participants with a clear path for changes in reinvestment policy that
will help avoid undue volatility in fixed income markets. The addendum
also outlines the criteria that the Fed will consider in deciding
whether to deviate from its announced principles. As balance sheet
normalization proceeds, the FOMC could provide a broad indication of
what the eventual monetary policy operating framework may look like
over a longer horizon. Continued clear communication will maintain the
Federal Reserve’s estimable track record of smoothly normalizing U.S.
monetary policy.

Strengthening the Foundations for Growth and Resilience

Taxes

14. The U.S. needs a fundamental tax reform. There is broad agreement on the objectives: simplify the system,
lower marginal rates, scale back the extensive network of tax
preferences, incentivize labor force participation, mitigate income
polarization, and support low and middle-income households. To provide
resources for fiscal outlays that can strengthen potential growth and
to contribute to the needed reduction in the public debt, tax reform
ought to be designed to be revenue enhancing over the medium-term. Such
a reform could include:

Business tax
. The U.S. corporate income tax could move to a rent tax (either a
cashflow tax or an allowance for corporate capital tax) with a
somewhat lower marginal rate. This would incentivize business
investment and lessen the existing bias toward debt finance. Such a
reform could be combined with an elimination of the various
corporate tax preferences that currently complicate the system,
making the tax code more equitable and efficient. Naturally, such a
change would have important domestic effects (on activity and
investment) and sizable international spillovers.

Taxing offshore profits.
The administration’s proposal to enact a one-time tax on the stock
of unrepatriated profits of multinationals deserves support as part
of a comprehensive tax reform package. Such profits could be taxed
at a rate that is modestly lower than the current corporate rate.
Providing only moderate tax relief would be efficient (since it is
a tax on past profits) particularly given that the
existing system of tax deferral has already conveyed significant
benefits to those taxpayers that have chosen not to repatriate
profits. Such a policy would generate a temporary uplift in fiscal
revenues and payment of the resulting tax liability could be spread
over several years to address liquidity concerns of affected
corporations. Transitioning to a territorial system, as has been
proposed by the administration, merits consideration but ought to
be combined with a minimum tax for profits earned in low tax
jurisdictions to limit the scope of profit-shifting.

Individual income tax.
Providing tax relief for low and middle-income groups, as has been
proposed by the administration, would help alleviate income
polarization and encourage labor force participation. The bulk of
itemized deductions can be eliminated alongside an increase in the
standard deduction. Any remaining deductions (e.g. for mortgage
interest and charitable contributions) could be capped. The
authorities could also expand eligibility and increase the
generosity of the earned income tax credit (EITC) to support lower
income households and incentivize work. To lessen the risk an
expanded EITC leads to a decline in pre-tax wages at the bottom of
the income distribution, the EITC expansion ought to be combined
with an increase in the federal minimum wage.

Pass-through entities.
Any tax rate reductions for pass-throughs need to take revenue
implications into account. Setting the effective rate on
pass-throughs below the effective rate on distributed corporate
profits or the top marginal personal income tax rate creates
important incentives for some firms to become pass-throughs and for
high income employees to become independent contractors in order to
lessen their tax burden.

Consumption taxes
. To ensure the overall tax reform is revenue-gaining the U.S. has
the scope to rely more on other revenue sources including a federal
level consumption tax, a broad-based carbon tax, and a higher
federal gas tax. To give a sense of what is feasible, a
broad-based, 5 percent consumption tax would generate around 1½
percent of GDP per year in revenues, a carbon tax of around US$45
per ton of CO2 would generate 0.5 percent of GDP per
year, and each 50 cents increase in the gas tax would raise
revenues of around 0.3 percent of GDP per year.

Infrastructure

15.
As pointed out in the administration’s budget, underinvestment in
infrastructure has become a growing constraint on private sector
productivity and long-term growth and job creation.
Investment in public infrastructure has declined significantly in the
post-recession period. This has led to a deterioration in the public
capital stock (particularly since maintenance spending has been
eroded). A permanent increase in federal, state and local
infrastructure spending of at least 0.5 percent of GDP per year is
needed (based on the American Society of Civil Engineers estimates of
the U.S. infrastructure gap). Priorities include improving the quality
and reliability of surface transportation and upgrading infrastructure
technologies (e.g., in high speed rail, ports, and telecommunications).
It will be important to ensure the right mix is achieved between the
public funding of maintenance and repair versus new projects. The
US$200 billion appropriation in the budget aimed at catalyzing US$1
trillion in private and public infrastructure investment would, if
realized, support long-term growth.

Financial regulation

16.
Important gains have been made in strengthening the financial
oversight structure since the global financial crisis.
There is scope to fine-tune some aspects of the system as has been
proposed by the U.S. Treasury. For example, there is a case for a
simpler regime for small and community banks, that is backed by
risk-based supervision, or a revisiting of the thresholds for
institutions to be subject to stress tests or to be considered
systemic. However, the current approach to regulation, supervision and
resolution should be preserved. This would include supporting the
Financial Stability Oversight Council in its efforts to identify risks
and respond to emerging threats to financial stability; extending the
analytical work of the Office of Financial Research; and continuing to
strengthen the Fed’s Comprehensive Capital Analysis and Review stress
testing exercise. The U.S. ought to maintain its special resolution
regime for systemic financial entities as a backstop to resolution
under the bankruptcy code so as to facilitate orderly resolution and
prevent any contagion that could put system-wide stability at risk. In
this regard, a court-based bankruptcy regime may prove insufficiently
nimble, lack the authority to provide needed temporary public financial
support, lead to a dilution of regulators’ powers, and give rise to
stability and contagion risks. The current risk-based capital framework
should not be replaced with a simple leverage ratio. Such an effort may
give incentives for banks to increase capital but also creates
incentives for capital to be placed into more risky activities. It
would be particularly problematic to allow banks to self-select into a
lower regulatory and supervisory regime, regardless of the underlying
systemic risk of their operations. Finally, the current designation
framework could be improved to be more expeditious, transparent, and
accountable. The maintenance of a robust financial regulatory regime in
the U.S. has had positive spillovers to others both by reducing
financial stability risks in the U.S. and the knock-on effects from
encouraging progress to strengthen the global regulatory framework.

Trade

17.
The U.S. commitment to free, fair and mutually beneficial trade and
to improving the rules-based international trading system is
welcome.
The U.S. has also reiterated that it intends to keep its markets open
and to fight protectionism, while standing firm against all unfair
trade practices. Open international trade has long supported U.S.
growth and job creation with positive spillovers for others. However, a
slower pace of global trade reform since the early 2000’s has left in
place trade barriers, subsidies, and other trade-distorting measures.
Further trade integration and the promotion of a level playing field in
international trade, particularly in growth areas such as services,
would offer important gains to the U.S. in terms of productivity,
economic growth, and job creation. U.S. participation in multilateral
efforts to resolve global excess capacity is welcome. However, the U.S.
ought to be judicious in its use of import restrictions on national
security grounds and avoid measures that inadvertently weaken, rather
than strengthen, the overall economy. Finally, there is scope to
modernize trade agreements (including NAFTA)—for example on
transparency provisions, e-commerce, services, as well as labor,
environmental and safety standards—in ways that are mutually beneficial
for all signatories. The U.S. would benefit by remaining open as it
pursues new or amended trade agreements.

Deregulation

18.
A central plank of the new administration’s economic plan is to
revisit federal regulations in a range of areas.
In international comparisons, the U.S. already scores favorably on
regulatory barriers to entrepreneurship, trade and investment.
Nonetheless, a simplification and streamlining of federal regulations
as well as an effort to harmonize rules across states would likely
boost efficiency and could stimulate job creation and growth. There may
also be scope to achieve desired outcomes through means other than
regulation (e.g. to replace regulatory limits on carbon with a
broad-based carbon tax). However, in reforming the current regulatory
system, care is needed to avoid negative consequences for the
environment, workplace safety, and protections for lower income
workers.

Maintaining a Productive and Flexible Workforce

19.
To complement the policies described above, there is a range of
measures that could be taken to increase the flexibility and
adaptability of households and businesses, to mitigate secular trends
in income polarization and poverty, raise labor force participation,
and create the environment to increase investments in human capital.
Many of these macro-critical areas would both raise potential growth
but would also help ensure that gains in income and opportunities are
able to improve the living standards of the majority of the population.
Such reform areas include:

Education

20.
Access to better and more cost-effective education can raise
productivity and increase the flexibility of U.S. workers to adjust
to structural shifts in labor demand or displacement by technology
or trade. There is also broad evidence that investments in education can lessen
the intergenerational persistence of poverty. Funding can be better
prioritized toward early childhood education (including instituting
universal pre-K) and to support science, technology, engineering, and
mathematics programs. There is also a strong case to redesign the
financing model for public schools to reduce funding differences across
districts and provide more resources to schools with high
concentrations of students from low income households. The
administration’s support for federal, state and local efforts to offer
attractive, non-college career paths (e.g., through apprenticeship and
vocational programs) is welcome. However, the high levels of private
and public expenditure on higher education, alongside relatively
unimpressive attainment statistics, suggest the need for a greater
focus on preparing students for college and fostering retention once
they are enrolled. Alternative state and federal financing options for
tertiary education may help increase access for students from lower and
middle income households.

Family-friendly benefits

21.
The cost and availability of childcare is a constraint to labor
force participation. It is also of concern that one-in-four single parent households are
living in poverty. The administration recognizes that family-friendly
benefits can be an important policy lever to slow the downward trend in
labor force participation and support low- and middle-income families.
In this regard, the budget’s intention to create a program that offers
six weeks of paid leave to new parents and provide help for families
struggling with child and dependent care expenses are positive steps.

Supporting low- and middle-income households

22.
Mitigating the ongoing hollowing out of middle-income earners and
reducing the currently high levels of poverty would raise labor
supply, boost human capital and productivity, and improve living
standards. In addition to the reforms discussed above—education, family-friendly
benefits, and expanding the EITC—other policies that could help
include:

Disability insurance
. As proposed in the budget, there is scope to strengthen the
design of the disability insurance program to provide incentives
for beneficiaries to work part time or eventually return to full
time work (rather than drop out of the labor force). Such a reform
ought to be undertaken carefully, however, to prevent legitimate
recipients being excluded from this important safety net.

Social assistance
. There is significant scope to upgrade federal and state-level
social programs to better help the most vulnerable. “Cliffs” in
social benefits—such as Medicaid, the Supplemental Nutrition
Assistance Program, the Child Health Insurance Program, Temporary
Assistance for Needy Families, and housing assistance—could be
reassessed with a view to smoothing the phase-out for the
near-poor. This would not only reduce disparities but also
encourage labor force participation for those earning above, but
close to, the federal poverty line. There is scope to simplify and
unify the various programs underlying the safety net, increase the
generosity of direct transfer programs, learn from the diversity of
experiences at the state-level to identify the most effective
approaches, and better-target federal payments to program outcomes.
These improvements to social programs could be undertaken with a
relatively small budgetary cost.

Immigration

23.
A skills-based immigration system would enhance labor participation
and productivity. The administration has recognized the importance of such reform.
Demographic changes will lead to a steady decline in labor force
participation in the coming years, slowing labor force growth from an
annual average of about 1 percent over the last 25 years to about ½
percent in the coming decade. The dependency ratio—the share of the old
and young population as percent of the working age population—is
expected to rise fromabout 60 percent today to 75
percent by 2037. This is even with around 0.6 million new immigrants
entering the labor force each year. A comprehensive, skills-based
reform of the immigration system has the potential to expand the labor
force, improve the dependency ratio, and raise the average level of
human capital. This could have significant positive effects on
long-term potential growth and help ease the medium-term fiscal
challenges.

Healthcare

24.
Health care policies should protect those gains in coverage that
have been achieved since the financial crisis (particularly for
those at the lower end of the income distribution) and contain
healthcare cost inflation. Doing so will have positive implications for well-being,
productivity, and labor force participation. This, in turn, will
strengthen growth and job creation, reduce economic insecurity
associated with the lack of health coverage, and have positive effects
for the medium-term fiscal position. Changes have been proposed to
remove the individual and employer mandates, eliminate various taxes
and subsidies, reverse the Medicaid expansion, and give states more
flexibility and control over the health care market. Such changes ought
to be undertaken carefully to avoid compromising the pooling of risks
(an essential foundation for a well-functioning health insurance
system) or excluding those with limited incomes from the healthcare
system. Mechanisms to encourage cost control in the provision of
services need to be examined, including through an evaluation of
existing pilot programs and an application of new technologies that can
increase efficiencies and pricing transparency. There also ought to be
some assessment of the scope for anti-trust actions where the market
concentration of providers or insurers has risen and where premiums for
non-group policies have been rising rapidly.

The Executive Board of the International Monetary Fund will
conclude the 2017 Article IV Consultation with the United States by
reviewing and discussing the IMF staff findings that have been
outlined in this statement. This Board discussion is currently
scheduled for July 24, 2017.